How Facebook Could Spend Its Cash Hoard

When you think of companies swimming in cash, Facebook (NASDAQ: FB) might not be the first to come to mind.

The social media giant is just 14 years old and has made a number of high-profile acquisitions in its history, including dropping $19 billion on messaging service WhatsApp in 2014. However, with giant profit margins, Facebook has built up a considerable nest egg in just a few short years. The company now has total cash and marketable securities of $42.3 billion and just $10.9 billion in total liabilities on its balance sheet. Is it time for Facebook to take out its wallet for another splashy acquisition? Let's take a look and see how the Instagram owner might spend its cash hoard.

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1. Acquisitions

During its short history, Facebook hasn't been shy about acquisitions. In addition to WhatsApp, the social networking titan took over popular photo-sharing app Instagram for $1 billion in 2012 and Oculus, the maker of virtual reality gear, for $3 billion in 2014. Instagram has been one of the most successful acquisitions in the history of tech, as the app now has more than a billion users, though WhatsApp and Oculus have yet to yield meaningful returns.

Facebook has long sought to bring other social media companies into its fold, which always seemed like the best way to eliminate competition and give a boost to start-up platforms like Instagram, as they can benefit from Facebook's ample funding, tech infrastructure, and advertising expertise. The company even made a bid for Snap Inc. (NYSE: SNAP), offering $3 billion in 2013, after sensing a threat from Snapchat. Instead, after getting rejected, Facebook copied "Stories" from Snapchat, launching it first on Instagram and then on both Facebook and WhatsApp, which has neutralized the threat from Snap.

Today, the social media landscape looks relatively sparse, at least outside of China. There's Facebook, with its subsidiaries; Twitter, which has mounted something of a comeback this year but suffers from widespread harassment as well as the same political hacking problems that have plagued Facebook; and Snap, whose shares have fallen to all-time lows since its IPO last year amid slowing user growth. Facebook's interest in Snap has probably waned now that it has rolled out Stories on its own platforms.

One possible acquisition could be Match Group (NASDAQ: MTCH), the parent of Tinder and a leader in the online dating industry, whose valuation has ballooned to $16 billion. Facebook said earlier this year it would launch its own dating product, but taking over Match would be an easier way to assert its power in the industry. The two businesses have a natural overlap, and Facebook's advertising acumen could benefit the company's ad-based products. However, companies like Match could be reluctant to sell to Facebook after a year's worth of scandals that have damaged Facebook's image and user trust. Regulators might also be reluctant to approve further acquisitions given the company's formidable market power. A Facebook takeover of Match could also turn off online daters who don't trust Facebook with their personal information and might resent a further incursion from the social media giant into their lives.

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The reason Facebook hasn't made a major acquisition in more than four years, during which cash and marketable securities more than quadrupled, might simply be because the company doesn't see any worth making, especially after acquiring WhatsApp and Oculus, which Facebook has yet to fully monetize.

2. Dividends

Facebook has never paid a dividend, and dividends are often considered anathema in the tech world. Apple visionary Steve Jobs famously refused to pay a dividend despite Apple's massive cash pile, and Google parent Alphabet has also never paid a dividend, despite having more than $100 billion in cash and investments on its balance sheet. In the tech industry, paying quarterly dividends is seen as a sign that the company's growth phase is over and that it has reached maturity, where it's content to be simply a cash machine.

However, despite this stigma, Facebook is a reasonable candidate to become a dividend payer. The company spins off cash like few other enterprises, with net income of $19.1 billion and free cash flow of $17.6 billion over its last four quarters, and it posted a whopping operating margin of 44% in its most recent quarter. Now that the company's P/E valuation has come down to just 25, it could offer a reasonable dividend yield if it chose to return capital to shareholders. However, the company has repeatedly dismissed the idea of paying a dividend, saying that it's better off investing in growth opportunities. With revenue still growing by 42% as of its most recent quarter, that seems like a reasonable argument. Though its valuation might indicate otherwise, Facebook is still very much a growth company.

3. Share buybacks

Share buybacks have become increasingly popular in recent years, as CEOs like Warren Buffett have found acquisitions to be too pricey and companies see fewer growth opportunities as we enter the tenth year of an expanding economy.

Though Facebook has resisted dividend payments, it has dabbled in share buybacks. Facebook announced its first buyback program in 2016, authorizing $6 billion for share repurchases, and has steadily ramped up buybacks since then. In its most recent quarter, the company repurchased $3.35 billion, a company record, though its share count has only been reduced by 0.7% over the last year, in part due to the company's use of share-based compensation.

However, with the stock down modestly and Facebook's P/E ratio at an all-time low of just 25, which is essentially identical to the S&P 500's at 25.3, the stock is cheaper than it has ever been and very reasonably priced considering the market average.

Buying back shares would help the company take advantage of its beaten-down stock price and boost earnings per share by reducing the number of shares outstanding. It would also send a signal to the market that it believes its stock is cheap.

Though share buybacks can be risky, as companies often overpay for their own stock and spend cash they later need, it looks like the best option for Facebook, especially with the stock looking cheap, considering its mounting cash hoard. The company is set to generate more than $20 billion in profits this year, and its bottom line is likely to keep growing in the coming years.

One logical option

There don't seem to be any reasonable acquisitions available for Facebook to make and regulators, or the potential target, are likely to look askance at a potential bid, especially considering Facebook's recent series of scandals and its considerable market power in social media. Dividends also seem like an unlikely option at this point as Facebook is still growing rapidly, so management would likely be reluctant to make the commitment to draining cash flows that a dividend implies.

That makes share buybacks the best option for the company. Repurchasing shares would return capital to shareholders, take advantage of the low valuation and boost its earnings per share. Most importantly, they would put its rapidly increasing cash pile to good use.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Jeremy Bowman owns shares of Facebook and Match Group. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, Facebook, and Twitter. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Match Group. The Motley Fool has a disclosure policy.